General Counsel Memorandum 39606
Internal Revenue Service (I.R.S.)
General Counsel Memorandum
Date Numbered: February 27, 1987
February 8, 1987
Section 61 — Gross Income v. Not Gross Income
Section 74 — Prizes and Awards
Section 165 — Deductions For Losses
Section 167 — Depreciation
Section 263 — Capital Expenditures (Deductible v. Not Deductible)
Section 1031 — Exchange of Property Held for Productive Use or Investment
Section 1221 — Capital Asset v. Not a Capital Asset
Section 1223 — Holding Period of Capital Assets
Section 1231 — Property Used in the Trade or Business and Involuntary Conversions (Capital Gain v. Ordinary Income Treatment)
Peter K. Scott
Associate Chief Counsel (Technical)
Attention: Director, Corporation Tax Division
By memorandum dated May 20, 1986, you informed us of a request from the United States Department of Transportation (DOT) for an explanation of the Federal income tax consequences of the sale or exchange of airplane takeoff and landing rights, or 'slots', at certain high-density airports. This request was prompted when the Federal Aviation Administration (FAA), a part of the DCT, instituted a 'buy/sell rule', effective on April 1, 1986, under which commercial airlines and other 'persons' are permitted to purchase, sell, lease, and trade their allocated slots at these airports. Most existing slots were allocated to their current holders ('incumbents') under a 'grandfather' provision. Some existing slots and newly-available slots will be allocated to new entrants and others in periodic lotteries.
You have requested our opinion on a number of issues raised by this buy/sell development. Our discussion will be restricted to the tax consequences under the Internal Revenue Code prior to its amendment by the Tax Reform Act of 1986, Pub. L. No. 99-514.
1. Is the fair market value of a slot includible in an airline's gross income under section 61 of the Code as a result of its initial acquisition from the FAA by an 'incumbent' airline, its receipt from the FAA in a lottery, or the institution of the buy/sell rule?
2. Must the costs of acquiring a slot be capitalized under section 263 of the Code? If so, may such costs be depreciated under section 167 of the Code?
3. Is income or loss from the use or disposition of a slot ordinary or capital in character?
4. Can gain or loss realized in a slot-for-slot trade qualify for nonrecognition under the 'like-kind exchange' provisions of section 1031 of the Code?
5. Can the reversion of a slot give rise to a loss deduction under section 165 of the Code? If so, is the loss ordinary or capital?
1. As in similar cases involving certain government-created rights and privileges, the initial acquisition of a slot from the Federal government-- whether by grandfathering an incumbent, by lottery, or by some other method--is not an event that results in the realization of gross income. Nor would the government's action in creating a market for airport slots, as of April 1, 1986, be a taxable event with respect to incumbent slot-holders.
2. A slot is a separate and distinct income producing intangible asset with an indefinite useful life, that is capable of being bought, sold, leased, or traded. The purchase price or other costs of acquiring a slot must be capitalized as part of the cost basis of the slot. These costs may not be recovered through a depreciation deduction, but only on abandonment or other disposition. In the case of a purchase of a slot along with other assets for a lump sum, an appropriate portion of the purchase price must be allocated to the slot.
3. Income from the use of a slot in commercial passenger airline operations is, of course, ordinary income.
Income from the 'lease' of a slot, as permitted by the FAA, would be ordinary in nature.
The character of gain or loss from the disposition of a slot depends on whether a slot is a 'capital asset' under section 1221 of the Code (or a 'quasi-capital asset' under section 1231); whether the transaction qualifies as a 'sale or exchange' under section 1222 (or 1231); and the length of the taxpayer's 'holding period' under sections 1222 and 1223.
In our opinion, a slot may, as a preliminary matter, come within the scope of the definition of a section 1221 'capital asset'. It is 'property' within the meaning of section 1221. Even though used in a taxpayer's trade or business, it would not be excluded from 'capital asset' status by section 1221(2), since it is neither depreciable nor real property. (By the same token, it cannot qualify as 'property used in the trade or business' under section 1231(b)).
Depending on the circumstances, a slot may be excluded from 'capital asset' status under section 1221(1) if held by a dealer. This possibility is enhanced by the FAA's intentional inclusion of non-airlines as 'persons' capable of acquiring slots.
Moreover, a taxpayer (such as a commercial airline) that uses a slot in its business could be viewed as realizing ordinary gain or loss from the sale of a slot by virtue of the judicial doctrine established in Corn Products Refining Co. v. Commissioner, 350 US 46 (1955). However, since the precise scope of the Corn Products doctrine is unclear, and there is a conflict among the circuit courts as to the basic scope of the Corn Products doctrine, with the distinct possibility of impending Supreme Court resolution of such conflict, we cannot at this time specify whether this doctrine would apply to the disposition of airport slots.
If, in a given case, a slot qualifies as a section 1221 capital asset, established principles would apply in determining whether the 'sale or exchange' requirement is met. Also, the holding period for incumbents, in our view, would commence some time prior to the FAA institution of the buy/sell rule, when the slot was first acquired under the prior allocation system. Further factual development would be required to establish the exact date.
4. A slot-for-slot trade may qualify as a nonrecognition transaction under Section 1031. Unless, in a given situation, a slot constitutes 'stock in trade or other property held primarily for sale', it would not be excluded from nonrecognition treatment by the exceptions in section 1031(a)(2). Two slots used for commercial air traffic are of 'like kind' whether they are for different times, or at different airports, or both.
5. Under the buy/sell rule, a slot may be forfeited pursuant to a 'use-or-lose' provision, or withdrawn for one of several reasons. Either event could give rise to a loss deduction under section 165 in the amount of the taxpayer's basis in the slot. This assumes there is a closed and completed transaction on the facts of the particular case.
The character of the loss, whether it resulted from forfeiture or withdrawal, would normally be ordinary either because the slot was not a capital asset in the taxpayer's hands, or because of the lack of a 'sale or exchange'.
In the late 1960's, congestion became a problem at several large metropolitan airports in the United States. This congestion was a function of several factors, including noise pollution restraints and limits on runway space, airspace, ground facilities, passenger terminal capacity, and air traffic control capacity. The Secretary of Transportation and the FAA have broad authority to regulate and control the use of the navigable airspace of the United States, in order to ensure its efficient utilization and the safety of aircraft. See sections 307(a) and (c) of the Federal Aviation Act of 1958 ('the FAA Act'), 49 USC section 1348(a) and (c). In 1968, the FAA issued a 'High Density Traffic Airports Rule', restricting the hourly number of takeoff and landing slots available at Kennedy, O'Hare, LaGuardia, Washington National and Newark airports. The rule establishes quotas on the number of IFR reservations per hour that will be accepted during certain hours of the day at these airports, based on the overall IFR capacity of the airport. Slots are allocated among three general classes of airport users: scheduled commercial air carriers, scheduled air taxis (commuter airlines), and all other operators--primarily general aviation but also charter operators.
The high density rule did not specifically provide a means of allocating slots to individual operators within each class. For commercial air carriers and commuter operators, this allocation was generally accomplished through the operation of eight 'scheduling committees' composed of incumbent operators and interested new entrants at each airport. Operating under a limited grant of antitrust immunity, these committees allocated slots through a voluntary bargaining process.
In the late 1970's the FAA became increasingly dissatisfied with the functioning of the scheduling committees, which were subject to delays and deadlocks. These problems were exacerbated by the increased demand for slots following the Airline Deregulation Act of 1978, 92 Stat. 1705, which phased out the functions of the Civil Aeronautics Board (CAB) in limiting the number of airlines that could service particular cities. Beginning in 1980, the FAA began considering alternatives to the scheduling committee system, including lotteries, auctions, and administrative allocation procedures.
On December 16, 1985, the DOT issued the current 'buy/sell' rule, amending the regulations under 14 CFR Parts 11 and 93 to authorize the transfer, for consideration, of slots at the four high- density airports. The rule applies only to the commercial air carrier and commuter slot pools. Initial acquisition of slots under the 'buy/sell' rule was accomplished by allowing each operator holding a permanent slot as of December 16, 1985, under the prior committee allocation system, to continue holding the slot. 14 CFR section 93.215(a). A small percentage of slots were reallocated in a lottery, in which new entrants had preference.
Effective April 1, 1986, the rule permits commercial air carriers, commuters, and other 'persons' to buy, sell, or lease slots for any consideration and for any time period, and allows trading of slots in any combination for slots at the same or another airport. 14 CFR section 93.221(a). The FAA intended slot ownership to be open to non-aviation entities such as banks, communities, and brokers to ensure that slots go to their most productive use. Transfers must be reported to and confirmed by the FAA, but confirmation will normally be automatic, unless the transfer would be injurious to the 'essential air services' (EAS) program. A certain number of slots are reserved for international and EAS flights; transfer of these slots is restricted to one-for-one intra-airport trades.
In certain circumstances a slot may revert to the FAA under the new regulations. First, under a 'use-or-lose' provision, any slot not used 65 percent of the time over a 2-month period will revert. Exceptions are made for strike and bankruptcy situations. 14 CFR section 93.227. Second, slots may be withdrawn at any time to fulfill operational needs, such as providing slots for international or EAS flights or eliminating slots. 14 CFR section 93.223. The regulations state: 'Slots do not represent a property right but represent an operating privilege subject to absolute FAA control.' 14 CFR section 93.223(a). It is not expected that the FAA will need to exercise its withdrawal authority except in extraordinary circumstances. The order in which slots will be recalled if withdrawal is necessary will generally be determined by each slot's 'withdrawal priority', established in lotteries conducted at the outset of the program. This withdrawal priority is an attribute of the slot that survives transfer to another owner or FAA reallocation. 14 CFR section 93.223.
The FAA will allocate or reallocate newly-available slots by means of periodic lotteries in which new entrants have preferences. Only air operators (i.e., not all 'persons') are eligible to obtain slots in this manner. 14 CFR section 93.225.
An operator using a slot it is not entitled to use is subject to a #1,000 maximum civil penalty for each unlawful takeoff or landing. 14 CFR section 93.229(a).
Since the buy/sell rule became effective, there has been considerable activity in slot sales. As of June 17, 1986, the FAA had confirmed 30 sales involving 96 slots. According to a DOT official, slots are worth $225,000 on the average, and the purchase price for some slots has been estimated at $1 million.
At this writing, bills are pending in both the House and Senate to repeal the buy/sell rule. Opponents say the rule allows private companies to profit from the sale of public assets.
ISSUE 1. INCOME ON INITIAL ACQUISITION FROM GOVERNMENT.
The threshold question raised in this case is whether a taxpayer realizes gross income for income tax purposes when it first acquires a slot from the FAA, or when a slot it holds is made transferable for consideration pursuant to the buy/sell rule.
Section 61 defines gross income as 'income from whatever source derived', except as otherwise provided by law. See Treas. Reg. 1.61- 1(a). Gross income includes income realized in any form, whether in money, property, or services. Id. This definition encompasses all 'accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.' Commissioner v. Glenshaw Glass Co., 348 US 426, 431 (1955).
In the present case, the exclusive landing or takeoff privileges that make up a 'slot' are clearly of significant value in producing income from airline operations, and the FAA's action in making slots transferable for consideration has enhanced that value. This benefit is derived from the Federal government. However, there is no general provision exempting Federal benefits from taxation. See, e.g ., Babocuivari Cattle Co. v. Commissioner, 135 F2d 114 (9th Cir. 1943) (government subsidies to cattle rancher taxable); Rev. Rul. 60- 32, 1960-1 CB 23, considered by this office in * * *, GCMs 29925/31036, A-622275 (March 11, 1957/Dec. 15, 1958) (Department of Agriculture payments and cost-sharing benefits under Soil Bank Act taxable). Although slots were not acquired in return for specific past or future services rendered to the government, that fact in itself does not prevent taxation under Glenshaw Glass and other established precedents.
However, in a wide variety of instances, the creation of property rights similar to the slots in issue, under an assortment of federal, state, and local licensing and other regulatory schemes, has not caused the recipient of such rights to be in receipt of gross income. This is true even though, in some cases, these rights are transferable, have an ascertainable fair market value, and were acquired at no cost or for a negligible fee. Rev. Rul. 67-135, 1967-1 CB 20, for example, holds that the difference, if any, between the fair market value and the cost of an oil and gas lease obtained by a taxpayer in a 'lottery' conducted by the United States Bureau of Land Management is not includible in the gross income of the leaseholder under section 61 at the time the lease is obtained.
In addition to such direct authority, there is indirect evidence for this proposition in many cases and rulings that discuss the tax treatment of the costs of acquiring government-created privileges, with respect to such issues as capitalization, depreciation, and loss. In these cases and rulings, a taxpayer who has acquired such an asset by purchase from a third party will have a basis in that asset corresponding to the purchase price. When the asset was acquired directly from a government entity, however, the basis in the asset will either be zero or will be made up of certain fees and related expenditures incurred in acquiring or defending the license or other right. Had the difference between these costs, if any, and the fair market value of the asset been taxed on acquisition, however, this difference would have been added to the taxpayer's basis. Cf. Treas. Reg. 1.61-2(d)(2)(i).
In Rev. Rul. 56-520, 1956-2 CB 170, for example, considered in * * *, A-618734, the Service considered the treatment of legal, engineering, and accounting fees and other expenditures incurred with respect to a contest, before the Federal Communications Commission, to determine whether the taxpayer should be awarded permission to use a certain channel for television broadcasting. The ruling holds, in part, that if the taxpayer succeeds, the expenditures must be capitalized as part of the cost of a nondepreciable intangible asset. There is no indication that the acquisition of this obviously valuable exclusive privilege is a taxable event.
The same inference can be drawn from Rev. Rul. 64-124, 1964-1 CB 105, Radio Station WBIR v. Commissioner, 31 TC 803 (1959), and Richmond Television Corp. v. United States, 345 F2d 901 (4th Cir.), rev'd and remanded on another issue, 382 US 68 (1965) (TV and radio broadcast licenses and permits); Rev. Rul. 56-600, 1956-2 CB 171, considered in * * *, GCM 29291, A-618003 (Feb. 6, 1956), and Rev. Rul. 67-113, 1967-1 CB 55, considered in * * *, GCMs 31143/33423, A-625853 (Mar. 13, 1959/Jan. 25, 1967) (CAB air route certificates); Rev. Rul. 67-141, 1967-1 CB 153, Rev. Rul. 83- 137, 1983-2 CB 41, and Nicolazzi v. Commissioner, 79 TC 109 (1982), aff'd per curiam, 722 F2d 324 (6th Cir. 1983) (oil and gas leases, consistent with Rev. Rul. 67-135); Rev. Rul. 70-644, 1970-2 CB 167, modified in Rev. Rul. 72-384, 1972-2 CB 479, clarified in Rev. Rul. 73-429, 1973-2 CB 304, revoked, but only in narrow circumstances, in Rev. Rul. 75-466, 1975- 2 CB 74, considered in 'Class I' Milk Bases in the Puget Sound, GCM 36420, I-3485 (Sept. 15, 1975) ('milk bases' entitling a producer to sell milk at a premium price under a Federal milk marketing order have a tax basis 'if purchased'); Rev. Rul. 66-58, 1966-1 CB 186, considered in Upland Cotton Allotment, I-2033 ('upland cotton acreage allotments' under Federal law); Nachman v. Commissioner, 191 F2d 934 (5th Cir. 1951), aff'g, 12 TC 1204 (1949) (city liquor licenses, cited in Rev. Rul. 56-520); Shufflebarger v. Commissioner, 24 TC 980 (1955), and Uecker v. Commissioner, 81 TC 983 (1983), aff'd per curiam, 766 F2d 909 (5th Cir. 1985) (Federal and state cattle grazing privileges, including renewable permits, leases and licenses). See also Standby Gasoline Rationing Plan, GCM 38237, I-3-80 at 3 (Jan. 10, 1980) (proposed transferable gas rationing coupons); * * *, GCM 37971, I-55- 78 at 6-7 (June 1, 1979) (milk base created under private rather than governmental scheme).
The intangible assets considered in these cases and rulings share with airport landing rights the characteristic of having been conferred by a governmental body in furtherance of government regulatory policies in allocating a limited resource. They may permit the holder to obtain 'monopolistic' or 'quasi-monopolistic' benefits. Yet, the determination in each of these situations has obviously been made that the value of such governmental licenses and permits will be taxed only as, and if, the taxpayer realizes that value through use or disposition.
We find no basis for distinguishing the landing rights in this case from the other governmental privileges just discussed. When an incumbent operator first obtained its slot under the pre-1986 scheduling committee system, that event was no different, in essence, from the acquisition of a CAB air route, an FCC broadcast channel, a milk marketing area milk base, or a county upland cotton acreage allotment. Nor do we think that the institution of the buy/sell rule changed the nature of grandfathered rights so markedly as to be considered a taxable event--either in December 1985, when incumbents first knew that their slots would be marketable, or on April 1, 1986, the actual effective date of such rule. The milk bases and cotton acreage allotments were marketable to third parties, but that fact did not cause the holders of those rights to be in receipt of gross income until such government created rights were disposed of to third parties. Finally, the fact that certain slots have been and will continue to be awarded in a lottery does not require their inclusion in income. Cf. Rev. Rul. 67-135, supra.
ISSUE 2. TREATMENT OF ACQUISITION EXPENDITURES.
Another issue you have raised is the proper treatment by the transferee of the price of a purchased slot (or, in the case of a slot acquired from the government, fees or other expenditures, if any, related to the acquisition).
The first question under this heading is whether these expenditures may be expensed when paid or incurred, or whether they must be capitalized. Generally, an expenditure must be capitalized under section 263 if the expenditure creates, enhances, or is part of the cost of acquiring or defending a tangible or intangible asset with a useful life greater than one year. Commissioner v. Lincoln Savings & Loan Ass'n, 403 US 345 (1971). A slot is an intangible asset the useful life of which, in terms of generating income, extends well beyond the taxable year. Expenditures related to the acquisition of a slot therefore fall squarely within section 263.
The second question is whether these capitalized costs may be recovered in advance of sale or other disposition of the slot through a deduction for depreciation. Under Treas. Reg. 1.167(a)-3, if an intangible asset is known from experience or other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy, such an intangible asset may be the subject of a depreciation allowance. . . . An intangible asset, the useful life of which is not limited, is not subject to the allowance for depreciation.
Most of the cases and rulings cited above under Issue 1 for their indirect implications with respect to income are directly in point on both the capitalization and depreciation questions. As discussed above, for example, Rev. Rul. 56-520 and the Richmond Television case call for the capitalization of various fees and expenses associated with the acquisition of broadcast rights, and go on to disallow a deduction for depreciation.
The right to take off or land at a certain time at a certain airport is not an asset with a determinable useful life. Under the buy/sell regulations, slots are not periodically reallocated, nor are they subject to periodic renewal or review by the government. This feature was intentional. The DOT believed that a market in permanent slots would permit long-range stability in carrier planning and marketing. Cf. Note, Airline Deregulation and Airport Regulation, 93 Yale L. J. 319, 331 (1983) (advocating a market in slots of finite duration). [FN10] In this respect, the case against the expensing or depreciation of slot acquisition costs is even stronger than in many of the cases and rulings cited above, in which periodic renewal of the rights in question was required, and yet the asset was still found to have an indefinite useful life because of the probability of renewal. See, e.g., Nachman, supra, 191 F2d at 935. Compare Rev. Rul. 67-113, supra (discussing the proper treatment of a variety of expenditures relating to 'temporary' and 'permanent' CAB air route certificates), with Van De Steeg v. Commissioner, 60 TC 17 (1973), aff'd per curiam, 510 F2d 961 (9th Cir. 1975) ('milk base' depreciable when milk marketing plan had a specific termination date). See also Rev. Rul. 75-466, supra (limiting Van De Steeg to a particular milk base marketing area).
Neither the fact that the regulations do not purport to create a property interest, nor the possibility that a slot might revert to the FAA in certain circumstances justifies the expensing or depreciation of slot acquisition expenditures. (As discussed under Issue 5 below, however, such a reversion may form the basis for a loss deduction under section 165). To cite an analogy, the FA Act, 49 USC section 1371(i), provides: 'No certificate shall confer any proprietary, property, or exclusive rights in the use of any air space, federal airway, landing area, or air navigation facility', and a certificate is revocable in the public interest. Yet the Service does not permit expensing or depreciation of acquisition costs for air route operating certificates. Rev. Rul. 56-500, supra. The forfeiture of a slot under the 'use-or-lose' provision in the buy/sell rule is an event essentially within the taxpayer's control. The possible withdrawal of a slot for operating reasons, like the possible adjustment or termination of the grazing preferences considered in the Shufflebarger case, see 24 TC at 995, is a contingency that is not geared to any period or the passage of time, and that may never happen.
We recognize that both the FAA and the airline industry are making efforts to alleviate congestion at the affected airports. Such factors as increases in airport capacity, technological developments, changes in the industry, etc., may lead at some point in the future to the elimination of slot constraints at some or all of the high density airports. Given the fact that these slot constraints have already been in effect for 18 years, however, and the fact that the FAA intentionally made slots infinite in duration under the buy/sell rule, we can find no basis at this point in time for a finding that a slot has a useful life of definite duration. In fact, according to testimony on June 17, 1986 by the American Association of Airport Exeutives before the Aviation Subcommittee of the U.S. House of Representatives Committee on Public Works and Transportation, FAA officials have recently projected that by 1990, 32 airports will require some slot constraints, and that by the year 2000, 61 airports will require some slot constraints. These projections certainly do not support a contention that slots have a useful life that can be estimated with reasonable accuracy. In fact, these agency projections indicate that slot constraints will probably be with us for the foreseeable future, and thus clearly have an indefinite and undeterminable useful life.
We have not addressed in this discussion exactly how a taxpayer would arrive at the proper basis for a slot in a given case. Questions could arise, for example, as to whether specific expenditures are sufficiently related to the acquisition of a slot to warrant capitalization. See, e.g., Richmond Television, supra, and related cases. In addition, although determining the basis of a purchased slot could be straightforward in many cases, this may not be true when, for example, a slot is acquired along with other slots or assets fr a lump sum. Beyond stating that in the latter case the transaction should be fragmented and an appropriate portion of the purchase price allocated to the slot, [FN11] these issues must be left for later development or case-by-case determination.
ISSUE 3. ORDINARY/CAPITAL CHARACTER OF INCOME FORM USE OR DISPOSITION OF SLOTS.
Since, at least under present law, the characterization of income or loss as either 'ordinary' or 'capital' can be crucial in determining the tax consequences for both individual and corporate taxpayers, an important issue in the present case is how income or loss from the use or disposition of airport slots will be treated.
It is obvious that an airline's use of a slot in its normal passenger operations will generate ordinary income. In addition, receipts from the 'lease' of a slot, as permitted by the regulations under the buy/sell rule, will be ordinary income to the lessor. The more difficult characterization issues arise on the sale or other disposition of all or some portion of a slot.
At the outset, we should note that under the buy/sell rule, taxpayers have considerable flexibility in structuring transactions in slots. The rule permits, for example, co-ownership of slots. It is our understanding that the rules would allow a situation in which one operator would use a given slot on certain days of the week, while a different operator would use it on the remaining days. In this discussion, however, we will focus on a simple hypothetical situation in which a taxpayer holding a slot transfers the entire slot to another party in return for a lump-sum cash payment.
Under the current law, the capital or ordinary character of gain or loss from the disposition of an asset depends on whether the asset is a 'capital asset' under section 1221 (or an asset described in section 1231), and whether the transaction qualifies as a 'sale or exchange' under section 1222 (or section 1231). The length of the taxpayer's 'holding period' under sections 1222, 1223, and 1231(b)(1) may also be significant in determining whether the transaction results in 'long-term' or 'short-term' capital gain or loss.
a. CLASSIFICATION AS 'CAPITAL ASSET'.
Section 1221 defines the term 'capital asset' as 'property held by the taxpayer (whether or not connected with his trade or business)'. Under sections 1221(1) through 1221(5), certain specified types of property are expressly excluded from being a capital asset. In addition to these 'statutory exclusions', capital asset status has been denied for certain types of assets under several judicial theories, the most notable of which was established in Corn Products Refining Co. v. Commissioner, 350 US 46 (1955).
(1) A SLOT AS 'PROPERTY'.
Before discussing the enumerated statutory exclusions and the Corn Products doctrine, we will address two related judicial theories that sometimes deny section 1221 capital asset treatment.
The first is that an item that might be viewed as property in some other context is not 'property' as that term is used in section 1221. An example of this approach, as well as a statement of the general policy considerations and rule of construction concerning the term 'capital asset', is found in Commissioner v. Gillette Motor Transport, Inc., 364 US 130 (1960). In Gillette, a taxpayer argued that compensation paid by the United States for temporary seizure of its business facilities during World War II was taxable as capital gain because the seizure was a taking of its 'property' under the just compensation clause of the Fifth Amendment. The Supreme Court held that neither the taxpayer's right to use its premises nor its right to be compensated for the temporary taking of its premises constituted 'property' within the meaning of the statutory predecessor to section 1221. The Court stated:
It is evident that not everything which can be called property in the ordinary sense and which is outside the statutory exclusions qualifies as a capital asset. This Court has long held that the term 'capital asset' is to be construed narrowly in accordance with the purpose of Congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time, and thus to ameliorate the hardship of taxation of the entire gain in one year
364 US at 134. The Court reasoned that the government 'took' only the right to use the underlying property for a temporary period, a right in which the taxpayer had no investment (and no basis) separate and apart from its investment in the underlying physical assets themselves. The compensation received by the taxpayer for the government's right to use the taxpayer's property was rent, and thus represented ordinary income to the taxpayer.
Another aspect of the same basic approach to the 'capital asset' definition is represented in such cases as Commissioner v. P.G. Lake, Inc., 356 US 260 (1958), and Hort v. Commissioner, 313 US 28 (1941). These cases stand for the proposition that Congress meant to exclude from 'capital asset' status rights to present or future income when the cash or other consideration for the transfer of those rights represents nothing more than a 'substitute' for income that would have been taxable to the transferor at ordinary rates had the transfer not been made.
Both the Gillette and P.G. Lake lines of reasoning have been recognized and employed in numerous cases. See, e.g., Commissioner v. Ferrer, 304 F2d 125 (2d Cir. 1962) (receipts from transfer of motion picture and dramatic rights by actor/producer); Foy v. Commissioner, 84 TC 50 (1985) (franchise rights). In determining whether contract rights should be considered 'property' within the meaning of sections 1221 and 1231, the courts have considered a variety of factors, including whether the rights are incident to, or create an estate in, specific real or personal property that is itself a capital asset, see Ferrer, supra; whether the transferred rights represent an interest that can appreciate in value over a period of years as the result of market forces, see Estate of Shea v. Commissioner, 57 TC 15 (1971), acq., 1973-2 CB 3; whether significant investment risks were associated with the transferred rights and included in the transfer, see Foy, supra; whether a market and a market price exists for the rights, see Ferrer; whether the rights primarily represented compensation for past or future personal services, id.; whether the taxpayer parted with the totality of its rights, or 'carved out' a portion in some fashion, see P.G. Lake, supra; whether the rights originated with the seller or purchaser, see Ferrer; and whether it is possible to assign a specific basis to the transferred rights, see Gillette, supra.
In the present case, the 'bundle of rights' represented by a slot can be viewed as comprising several elements. One salient element is the right to use the slot: i.e., the right to take off or land every day at a particular time at a particular airport for a commercial purp se. This right to use could be further broken down into different aspects, such as a right to occupy runway space, a right to use the navigable airspace of the United States at a particular time, a right to air traffic control and other airport services, a right to generate a certain amount of noise pollution, etc. The slot-holder also has the right to exclude others from interfering with these privileges. Not only can the slot-holder seek the imposition of a $1,000 penalty by the FAA for unauthorized use of a slot, but in addition it seems highly unlikely that, as a practical matter, unauthorized use could continue for long in such a heavily-regulated environment.
Under both pre-1986 and post-1986 FAA regulations, the holder of a slot has the right to transfer the slot in exchange for a different slot. Under the buy/sell rule, a slot carries with it the right to lease and a right to sell or otherwise transfer a slot subject to minimal restrictions. Under the pre-1986 rules a slot could only be transferred for consideration as part of a transfer of the business as a going concern. Under the buy/sell rule, a slot may be transferred by itself or in combination with other assets, and it is not necessary to be an actual carrier or have any other investment in, or connection with, an airport in order to hold or transfer a slot. Although the government may withdraw a slot, an individual slot carries with it a certain withdrawal priority right. Finally, subject to the 'use-or- lose' and withdrawal contingencies, the foregoing rights are permanent under the regulations.
In terms of the factors identified in Ferrer and the other cases discussed above, we believe that the 'bundle of rights' represented by an entire slot qualifies as 'property' within the meaning of sections 1221 and 1231. While a holder's rights in a slot do not represent an interest in some other specific property, they are themselves valuable, transferable rights enforceable through civil penalties. A slot is an interest that can fluctuate in value over a period of years, and the value of a slot when a transfer is made would not be attributable to any specific past or future efforts on the part of the transferor. The rights inherent in such a transferred slot do not originate with either the seller or the purchaser. Assuming that a taxpayer parts with an entire slot instead of carving out a portion limited in time or in some other fashion, the transferor has parted permanently with all operating and economic privileges associated with that slot, and has shifted the investment risks to the transferee. Such a taxpayer has not simply substituted one source of ordinary income for another. Finally, we view a slot as a discrete asset, representing an investment severable from such other assets as an operator's terminal facilities, other slots, or the particular air route for which a slot is used. [FN13]
The regulations under the buy/sell rule state that slots do not represent a property right but only an operating privilege subject to absolute FAA control. In our view, this does not prevent the transfer of a slot from one holder to another from being treated as a sale of 'property' for Federal income tax purposes. This statement in the FAA regulations is intended to address the status of slots in certain non- tax legal contexts. For example, whether an individual has 'vested rights' in government benefits may be significant in determining if certain procedural restrictions apply as a matter of constitutional or administrative law when those rights are withdrawn or modified. See, e.g., Northwest Airlines, Inc. v. Goldschmidt, 645 F2d 1309, 1321 (8th Cir. 1981). There has also been litigation concerning whether an airport slot is 'property' under certain provisions of the Bankruptcy Code. See, for example, In re Braniff Airways, Inc., 700 F2d 935, 942 (5th Cir. 1983), in which the court, as an alternative ground for its holding that the bankruptcy court had no jurisdiction to order the transfer of the bankrupt's slots, held that the landing slots were not 'property' of the bankrupt's estate under 11 USC section 105, since '[t]he slots are actually restrictions on the use of property-- airplanes; not property in themselves.' Accord, In re Air Illinois, Inc ., 53 BR 1 (Bankr. SD Ill. 1985); contra, In re American Central Airlines, InC., 52 BR 567, 571 (Bankr. ND Iowa 1985) ('Although the FAA may remove a slot at any time, until such action is taken, the holder has a possessory interest in a slot at the given airport').
Whatever significance the FAA's regulation may have in these non- tax contexts, and whatever significance it may have when the issue is the tax treatment of transactions with the government, we do not believe that the presence or absence of vested property rights vis-a- vis the government is controlling in determining whether transactions between third parties are dealings in 'property' under the Internal Revenue Code. As discussed above under Issue 2, this factor is not controlling in determining whether capitalization is required or depreciation allowed.
The conclusion that an airport slot may qualify as 'property' under sections 1221 and 1231 is buttressed by analogy to the tax treatment of similar exclusive privileges created by governmental action. Rev. Rul. 66- 58, supra, holds that an upland cotton acreage allotment--representing the right to certain price support payments and loans for cotton grown on alloted acreage under the Agricultural Adjustment Act of 1938--is an intangible property right that qualifies as a capital asset under section 1221, if held by a taxpayer who is not a dealer in such allotments. See also Rev. Rul. 70- 248, supra (California liquor business license); Rev. Ruls. 70-644 and 75-466, supra (holding, together, that outside of certain narrow circumstances, 'milk bases' under several specific Federal and state milk marketing orders qualify as section 1221 capital assets).
(2) INVESTORS IN SLOTS.
Given that an airport slot is 'property' under section 1221, classification of an airport slot as a 'capital asset' may still depend on the holder's motives and the way in which the slot is used-- whether, for example, a particular holder is an investor in slots, a dealer in slots, a user of slots, or combines these roles in some fashion.
If an airport slot is held solely for investment, any gain or loss would be capital in nature under section 1221. Cf. Rev. Rul. 73- 428, 1973-2 CB 303 (royalty interest in oil and gas held for investment is a capital asset). The fact that the FAA has broadened the class of slot-holders to include non-airline 'persons' raises this possibility.
Given the 'use-or-lose' provision, a non-airline would not be able to hold a slot for any significant length of time without leasing it, which might in some circumstances raise an issue as to whether such a holder was in the trade or business of leasing slots. See, e.g., Fackler v. Commissioner, 133 F2d 509, 511-12 (6th Cir. 1943). Such a finding would put the holder in the same category as an airline slot-holder, insofar as it would raise the section 1221(2) and Corn Products issues discussed below.
(3) DEALERS IN SLOTS UNDER SECTION 1221(1).
Another possibility, for both airline and non-airline slot- holders, is that the circumstances of a given case may indicate that the taxpayer is a dealer in slots, falling under the statutory exclusion in section 1221(1). Section 1221(1) excludes from 'capital asset' status stock in trade, inventory, and property held primarily for sale to customers in the ordinary course of the taxpayer's trade or business. Here again, the FAA's action in making slots readily transferable and making non-airlines potential transferees raises the possibility that a particular slot-holder may be a dealer under section 1221(1). Cf. Rev. Ruls. 66-58 and 70-644, supra.
(4) SLOT USERS: SECTIONS 1221(2) 1231, AND THE 'CORN PRODUCTS' DOCTRINE.
In the majority of cases, of course, airport slots will probably continue to be held by actual commercial airline operators. Section 1221(2) excludes from the definition of a capital asset a taxpayer's property that is 'used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business.' Although depreciable property and real property held for business use are thus excluded from capital asset status under section 1221, such assets are entitled to preferential treatment under section 1231 if they are held for more than six months. See IRC 1231(b)(1). Section 1231 provides generally for capital gain or ordinary loss treatment on the sale or exchange of such assets, depending on the outcome of netting computations involving the aggregate gains and losses for the tax year from such sales or exchanges and certain involuntary conversions of assets.
In our opinion, an airport slot used in a taxpayer's trade or business is not excluded from the definition of a 'capital asset' by section 1221(2), since a slot is not depreciable; as discussed above under Issue 2, and is not real property. For the same reason, a slot cannot qualify as depreciable or real 'property used in the trade or business' as that term is defined in section 1231(b)(1).
The finding that a slot is not 'real property' within the meaning of sections 1221(2) and 1231(b)(1) merits further discussion. For section 1231 purposes, 'real property' includes enforceable interests in real property, such as leaseholds, Rev. Rul. 72-85, 1972-1 CB 234 considered in * * *, GCM 34649, I-615 (Oct. 19, 1971); oil and gas leases and royalties, Rev. Ruls. 68-226, 1968-1 CB 362, and 73-428, supra; easements, Rev. Rul. 59-121, 1959-1 CB 212, considered in * * *, GCM 30186, A-623501/A-623508 (July 30, 1957); water rights, Rev. Rul. 73-341, 1973-2 CB 306; and 'transferable development rights' in agricultural property, Rev. Rul. 77- 414, 1977-2 CB 299, considered in * * *, GCM 36405, I-184-75 (Sept. 8, 1975). Cf. Rev. Rul. 71-286, 1971-2 CB 263 (air rights).
Although, at first impression, it might seem that a airport slot bears a resemblance to some of these interests, it is clear that the holder of a slot has no enforceable interest in any specific real property. A slot grants permission to occupy a runway and/or the navigable airspace of the United States for a certain purpose at a certain time (in addition to the right to air traffic control and other support facilities, the right to generate a certain amount of noise in the vicinity of the airport, etc.). However, such revocable license rights are no more an interest in real property than a state driver's license is an interest in the state roads over which one may drive.
Under section 1221, a 'capital asset' includes property held by the taxpayer 'whether or not connected with his trade or business'. Since, with respect to property used in a taxpayer's trade or business, section 1221(2) excludes only real property and depreciable property, the statutory language creates a presumption that NONdepreciable, PERSONAL property used in the trade or business, other than property covered by sections 1221(1), (3), or (4), qualifies as a section 1221 capital asset. This presumption is strengthened by the general balance sheet treatment of such items as land, franchises, licenses, customer lists, or purchased goodwill with no definite useful life as capital assets representing long-term investments that may appreciate in value, even though also used to produce income in the normal course of business. On this basis, a slot acquired by an airline for use in its trade or business would seem to fall within the scope of the term 'capital asset' in section 1221.
There is analogous support for this conclusion in the rulings and cases discussed above holding that such intangible, nondepreciable assets as liquor licenses, 'milk bases', and cotton acreage allotments are capital assets, even though used as an essential part of the taxpayer's trade or business. Rev. Rul. 66-58, for example, holding that a cotton acreage allotment is a section 1221 capital asset if held by a taxpayer who is not a dealer, states that 'it would generally be necessary for a taxpayer engaging in the business of growing and selling upland cotton to have an upland cotton acreage allotment.' 1966-1 CB at 186-87. See also, Rev. Rul. 70-248, 1970-1 CB 172, with respect to the capital asset character of a renewable state liquor license; Rev. Rul. 70-644, supra, 1970-2 CB at 168, with respect to the section 1221 capital asset status of certain 'milk bases'. There is also an analogy to such privately-created intangible assets as franchises, which may be section 1221 capital asset even though they are used in the trade or business and may be nondepreciable. See, e.g., Rev. Rul. 71-123, 1971-1 CB 227 (professional football franchises); Foy v. Commissioner, 84 TC 50 (1985) (professional janitorial services franchises). See also S. Rep. No. 552, 91st Cong., 1st Sess. at 207-10 (1969), reprinted in 1969-3 CB 423, 554- 56 (discussing the history and purpose of section 1253 of the Code, added in 1969 to specify the tax treatment of most franchise, trademark, and trade name transfers). The capital gain treatment generally accorded goodwill is also analogous, in the sense that goodwill can be viewed as a nondepreciable intangible asset used in the trade or business.
Capital asset treatment for intangible nondepreciating personal property used in a trade or business (and not described in any of the other enumerated statutory exclusions) is also consistent with the legislative history of sections 1221(2) and 1231. From 1921, when Congress first distinguished between capital and ordinary gains, until 1938, when the predecessor to section 1231 was enacted, the definition of a capital asset included all property used in a trade or business (i .e., that was not stock in trade, inventory, or primarily held for sale in the ordinary course of business). In the Revenue Act of 1938, 52 Stat. 500, Congress excluded 'depreciable property used in a trade or business' from the definition of a capital asset. The reason was to allow losses from the sale of depreciable assets to be deducted in full against ordinary income. Land used in the trade or business, however, was still subject to capital treatment. See H. Rep. No. 1860, 75th Cong ., 3d Sess. 7-8 (1938), reprinted in 1939-1 (Part 2) CB 728, 732-33.
In 1942, Congress created the predecessor to current section 1231 by providing that gains on depreciable property used in the trade or business, held for a certain period, should generally be taxed as capital gains, although losses on such assets would remain ordinary. At this point, land used in a trade or business, though nondepreciable, was excluded from the 'capital asset' definition and included with depreciable real estate improvements under the predecessor to section 1231. See S. Rep. No. 1631, 77th Cong., 2d Sess. 49-50 (1942), reprinted in 1942-2 CB 504, 545. There was no indication in either 1938 or 1942 that nondepreciable personal property used in the trade or business should not continue to be treated as a capital asset, where no other statutory exclusion is applicable.
However, the mere fact that property used in the trade or business falls outside the specific statutory exclusion in section 1221(2) does not render gain or loss from its sale immune from treatment as ordinary in nature. In Corn Products Refining Co. v. Commissioner, 350 US 46 (1955), the Supreme Court affirmed a lower court finding that a taxpayer's acquisition and sale of corn futures were an integral part of the everyday operations of the taxpayer's business, and held that transactions in those corn futures gave rise to ordinary gain or loss, rather than capital gain or loss, because the corn futures were not capital assets in the hands of the taxpayer. The Court in Corn Products construed the term 'capital assets' narrowly to effectuate the congressional purpose of the capital gains provisions of the Code, stating:
Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by section 117 [the predecessor of section 1221] applies to transactions in property which are not the normal source of business income. . . . Since this section is an exception from the normal tax requirements of the Internal Revenue Code, the definition of a capital asset must be narrowly applied and its exclusions interpreted broadly. . . . This Court has always construed narrowly the term 'capital assets' in section 117. 350 US at 52.
Since 1955, the judicial doctrine created in the Corn Products decision has been applied in a wide range of situations, involving both gain and loss, different types of assets, occassional or even one-time as well as recurring transactions, and a variety of business motives, such as ensuring a source of supply or a position as supplier, acquiring the business expertise and experienced personnel of an acquired corporation, maintaining a position as an employee or corporate officer, or protecting a business reputation. See Campbell Taggart, Inc. v. United States, 744 F2d 442 (5th Cir. 1984), and cases discussed therein.
No clear-cut test for determining when the Corn Products principle will apply has emerged from the case law. In Booth Newspapers, Inc. v. United States, 303 F2d 916, 921 (1962), which involved the purchase of stock of a paper mill company to assure the taxpayer-purchasers a supply of newsprint at a time when there were serious shortages of such paper, the Court of Claims expressed what has sometimes been termed the 'business/investment purpose' test (now generally applied), and some of the factors considered under that test:
If securities are purchased by a taxpayer as an integral and necessary act in the conduct of his business, and continue to be so held until the time of their sale, any loss incurred as a result thereof may be fully deducted from gross income as a business expense or ordinary loss. If, on the other hand, an investment purpose be found to have motivated the purchase or holding of the securities, any loss realized upon their ultimate disposition must be treated in accord with the capital asset provisions of the Code.
Thus, the circumstances of the transaction (its factual background, the necessities of the particular business involved at the particular time involved, and the intentions of the taxpayer, both at the time the securities were originally purchased and at the time they were disposed of) are of crucial importance in the resolution of these cases.
This focus on the business versus investment motive of the taxpayer was further refined in a significant Tax Court decision, W. W. Windle Co. v. Commissioner, 65 TC 694 (1976), APPEAL DISMISSED, 550 F2d 43 (1st Cir. 1977), cert. denied, 43 U.S. 966 (1977). In Windle, the Tax Court ruled that when a taxpayer's motives for acquiring and holding stock are mixed, that is both business and investment, gain or loss on disposition will be capital in nature if the taxpayer had a 'substantial investment motive', even though the taxpayer also had a predominant business motive, for acquiring or continuing to hold the stock. The Windle test has been adopted by the Government, at least as applied to stock, see Rev. Rul. 78-94, 1978-1 CB 58, and by at least one circuit court, see Wright v. Commissioner, 756 F2d 1039 (4th Cir. 1985).
A review of cases and rulings involving the characterization of non-stock assets used in a trade or business, but not covered by section 1231, does not furnish a conclusive answer as to whether the Corn Products principle would or would not apply to the disposition of airport slots owned by a commercial operator. COMPARE, for example, Rev . Rul. 66-58, supra (cotton acreage allotments), Caboara v. Commissioner, TC Memo 1977-355, 36 TCM (CCH) 1420 (liquor licenses), Rev. Rul. 70-644, supra (milk base), and Foy v. Commissioner, supra, 84 TC at 66 (franchises), all of which suggest that Corn Products would not apply to the disposition of airport slots--WITH Norton v. United States, 551 F2d 821 (Ct. Cl. 1977) (ordinary income on sale of contract right to cut timber on U.S. Forest Service land), and Becker Warburg Paribas Group, Inc. v. United States, 514 F. Supp. 1273 (ND Ill. 1981) (ordinary loss on sale of seat on New York Stock Exchange), which suggest that Corn Products would apply to the disposition of airport slots.
To further complicate the analysis, a recent opinion by the Eighth Circuit Court of Appeals has resulted in a clear split in the circuits concerning the scope of the Corn Products doctrine. In Arkansas Best Corp. v. Commissioner, 800 F2d 215 (8th Cir., Sept. 9, 1986), rev'g on this issue, 83 TC 640 (1984), the court held that loss on the sale of a holding company's stock in a bank resulted in a capital loss, on the ground that business/investment intent is irrelevant under section 1221 and Corn Products should not be extended beyond its facts. In adopting this rationale the court went beyond the Government's argument, which was based on Windle and Rev. Rul. 78-94, and placed itself squarely in opposition to most other courts, which have used some form of business/investment motive analysis in applying Corn Products.
Moreover, the Eighth Circuit's decision in Arkansas Best seems to be clearly in conflict with the Fifth Circuit's decision in Campbell Taggart, Inc. v. United States, 744 F2d 442 (1984), another case involving a holding company's sale of stock. In Campbell Taggart, the Fifth Circuit held that loss on the sale of stock acquired to preserve the taxpayer's business reputation was ordinary in nature, on the ground that stock is entitled to ordinary asset treatment when there is no investment purpose and it was acquired as an indirect means of incurring otherwise deductible business expenses. See id. at 451.
In view of this conflict between the circuits and possible Supreme Court review of the Arkansas Best decision, we believe that, apart from noting the potential for the Corn Products doctrine to apply to the disposition of airport slots, the Service is not in a position at this time to give a definitive answer concerning the general application of the doctrine in the different factual settings in which the slot disposition issue might arise.
b. THE 'SALE OR EXCHANGE' REQUIREMENT.
In order for gain or loss on a section 1221 capital asset to qualify for treatment as capital rather than ordinary, it must result from a 'sale or exchange' of that asset. See IRC 1222. The 'sale or exchange' requirement has been interpreted as encompassing a narrower class of transactions than is covered by the term 'sale or other disposition' in section 1001(a). Helvering v. William Flaccus Oak Leather Co., 313 US 247 (1941).
The 'sale or exchange' requirement has sometimes been the focus of controversy when intangible assets are transferred in situations indicating that the transaction is, in substance, a license or lease. Such questions may arise, for example, when the consideration for the transfer is contingent on the transferee's sales or profits from the transferred property, when the transferee parts with rights in certain geographical areas or fields of use only, or when the transferor retains control rights in the transferred asset. See, e.g., Resorts International, Inc. v. Commissioner, 60 TC 778 (1973), aff'd in part and rev'd in part, 511 F2d 107 (5th Cir. 1975) (retail paint store 'franchises'). In many contexts, the 'sale or exchange' issue is now governed by specific statutory provisions. See, e.g., IRC 1235 (patents); IRC 1253 (franchises, trademarks, and trade names).
No specific statutory provision would apply to airport slot transactions, and the 'sale or exchange' requirement might well become an issue in a particular case. However, we would regard the 'sale or exchange' requirement as having been clearly satisfied in the basic hypothetical situation that we are focusing on in this discussion: i.e., the absolute transfer of an entire individual slot for a lump sum . We would not view such an arrangement as some form of license or sublicense.
c. HOLDING PERIOD.
Section 1222 classifies capital gain or loss as 'short-term' or 'long-term' depending on whether the capital asset has been held for more than 6 months at the time of its sale or exchange. Section 1223 provides for the 'tacking' of holding periods in certain cases in which there is an 'exchange' of assets and the taxpayer's basis carries over from the transferred asset to the asset received (because gain or loss is not recognized on the transaction). The 'short- term/long-term' classification has significant consequences in determining the extent of preferential treatment under sections 1201, 1202 and 1211.
In Curtis v. United States, 336 F. Supp. 672 (WD Wash. 1972), the issue was when the holding period began for the taxpayers 'milk base' under a federal milk marketing order applicable to the Puget Sound, Washington, area. The government argued that the holding period began in September 1967, when a new 'Class I Base Plan' went into effect. The taxpayers maintained that it began in February 1967, when they received their allotment under the old plan. The court held for the government on the theory that the September 1967 regulatory action had extinguished the taxpayers' previous rights and created a new asset, and that there had been no 'exchange' that would permit the tacking of holding periods under section 1223. The key factor in the court's decision was that the September 1967 order provided for the first time that 'milk bases' could be transferred separately from a producer's dairy herd.
The Curtis 'two-asset' theory was not followed, however, in Rev. Rul. 73- 416, 1973-2 CB 304, and Rev. Rul. 73-429, 1973-2 CB 305, both considered in * * * / Class I Milk Bases, Puget Sound, Washington, GCMs 35208/35392, I-4852/I-3485 (Jan. 24, 1973/July 6, 1973). Rev. Rul. 73- 416, for example, holds that a producer's holding period for a California 'Class I milk production base' and 'milk pool quota' began on the day following the date those rights were originally acquired under the California Agricultural Code of 1933, despite the fact that subsequent legislation, the Gonsalves Pooling Act, permitted the producer to dispose of production base and pool quota separately from the producer's other dairy business assets. Rev. Rul. 73-416 states that '[t]here was no termination of existing rights and the creating of new rights wholly independent of the old rights provided under the Agricultural Code of 1933.' 1973-2 CB at 305.
In the present case, an airline that held a permanent slot prior to December 1985 was generally entitled to retain that slot under the buy/sell rule. Both before and after the institution of the rule in December 1985, such an incumbent slot-holder's underlying operating and economic rights remained substantially the same and stemmed from the same underlying legislative authority. In our view, neither the fact that the mechanics of slot allocation where changed, cf. Rev. Rul. 73-429, nor the fact that slots were made transferable separately from the rest of an airline's business assets, cf. Rev. Rul 73-416, compels a conclusion that an incumbent lost one asset and received a new asset when the buy/sell rule went into effect.
The holding period for an incumbent's slot would therefore begin the day after it received the slot under the scheduling committee allocation system in effect prior to the institution of the buy rule, rather than on December 17, 1985 or April 2, 1986.
Issue 4. SLOT TRADES AS 'LIKE-KIND EXCHANGES'.
The buy/sell rule expands the possibilities, already available to some extent under the prior scheduling committee system, for trading in slots. This raises the question whether gain or loss realized in a slot-for-slot trade may qualify for nonrecognition under the 'like- kind exchange' provisions of section 1031. Under section 1031(a)(1) of the Code, no gain or loss is recognized if property held for productive use in a trade or business or for investment is exchanged solely for property of like kind to be held either for productive use in a trade or business or for investment.
Section 1031(a)(2) excepts certain types of property from nonrecognition treatment, including (A) stock in trade and property held primarily for sale; (B) stocks, bonds, or notes; (C) other securities or evidences of indebtedness or interest; (D) partnership interests; (E) certificates of trust or beneficial interests; or (F) choses in action.
Just as an airport slot qualifies as 'property' under section 1221, as discussed above, we believe it falls within the scope of the term 'property' as used in section 1031(a). Although section 1031 is perhaps most often applied to exchanges of tangible real property, it may apply to intangible personal property, such as the slots at issue here, as well. See, e.q., Rev. Rul. 71-137, 1971-1 104, 105 (trades of player contracts owned by professional football teams). Certain types of intangible personal property, such as securities, partnership interests, and 'choses in action', are specifically excluded under sections 1031(a)(2)(B) through (F). See, e.g., Rev. Rul. 78-135, 1978- 1 CB 256, considered in * * *, GCM 37347, I-340-77 (Dec. 15, 1977) (holding, prior to the 1984 legislative addition of partnership interests to the exclusions in 1031(a), that such interests are not eligible for section 1031 treatment); Reconsideration of Rev. Rul. 69- 467, GCM 38653, I-42-79 at 5-6 (Mar. 11, 1981) (reasoning that both a Federal oil and gas lease application and an overriding royalty interest contingent on issuance of the lease are 'choses in action' ineligible for section 1031 treatment). In our view, a slot does not represent an equity interest similar to stock or a partnership interest . Moreover, inasmuch as it entitles the slot-holder to present operating privileges, a slot is distinguishable from the type of contingent contractual interests found to be 'choses in action' in GCM 38653, supra.
Assuming, therefore, that the slot transferred and the slot received in an exchange are held by the taxpayer for the requisite productive business use or for investment, and not for sale within the meaning of section 1031(a)(2)(A), the exchange should be eligible for section 1031 nonrecognition treatment, if the 'like kind' requirement is satisfied.
As Treas. Reg. 1.1031(a)-1(b) indicates, the words 'like kind' have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under section 1031, be exchanged for property of a different kind or class.
Thus, in general, we would view two slots as properties of like kind, the exchange of which does not represent the taxable position of a taxpayer's property. Such differences as the fact that one slot is for take-off and the other exchanged slot is for landing, or that the two slots are for different times, would not afect the basic nature of the two slots to the extent that recognition treatment would be called for. Nor is there any reason to confine 'like-kind' treatment to intra-airport trades. A slot at one high density airport represents an investment similar to a slot at another high density airport, especially when one considers that a slot at one airport can never be considered in isolation, but is necessarily linked to a take-off or landing at another airport.
Prior to 1986, the FAA limited slot trades to one-for-one transactions. This restriction has been lifted under the buy/sell rule, raising an issue as to the tax treatment of a multiple slot trade, such as the exchange of a slot at one airport for two slots at another airport. While each case should be examined to determine whether the transaction is taxable, in whole or in part, nonrecognition treatment under section 1031 is not restricted to one- for-one exchanges, and a multiple slot trade could qualify. See Rev. Rul. 68-36, 1968-1 CB 357 (involving proper basis allocation in the case of a qualified section 1031 exchange of one rental property for two other rental properties); Rev. Rul. 73-476, 1973-2 CB 300 (exchange of interests in three separate real estate parcels for full ownership in one qualifies under section 1031).
Issue 5. REVERSION OF SLOT TO GOVERNMENT AS DEDUCTIBLE LOSS.
Under the buy/sell rule, a slot not used 65 percent of the time over a two-month period will revert to the FAA. In addition, slots may be withdraw by the FAA to fulfill operational needs. The possibility that a slot may revert in either of these situations raises issues as to the availability of a loss deduction under section 165 of the Code and, assuming a deduction is available, the amount and ordinary or capital character of the deduction.
a. 'CLOSED AND COMPLETED TRANSACTION' REQUIREMENT.
Section 165(a) of the Code provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated by insurance or otherwise.
Treas. Reg. 1.165-1(b) provides that to be allowable as a deduction under section 165(a) of the Code, a loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. Only a bona fide loss is allowable.
Treas. Reg. 1.165-2(a) provides that a loss incurred in a business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in such business or transaction of any nondepreciable property, in a case where such business or transaction is discontinued or when such property is permanently discarded from use therein, shall be allowed as a deduction under section 165(a) for the tax year in which the loss is actually sustained.
In any case involving a claimed loss deduction, the facts of the case must be examined to determine, first, the relevant 'transaction', and second, whether that transaction was 'closed and completed'. See, e .g., Nicolazzi v. Commissioner, supra, 79 TC at 130-32 (portion of fees attributable to unsuccessful oil and gas lease applications not deductible, since 'transaction' was an integrated program designed to acquire one or more leases). A deduction is not allowable for a mere diminution in value of an asset. See, United States v. S.S. White Dental Manufacturing Co., 274 US 398 (1927); Louisiana Land & Exploration Co. v. Commissioner, 161 F2d 842 (5th Cir. 1947), aff'g, 7 TC 507 (1946), supra., 1946-2 CB 3 (with respect to an unrelated issue).
In most situations, the forfeiture of an airport slot under the 'use-or-lose' provision of the buy/sell rule would constitute an abandonment of a nondepreciable asset giving rise to a loss deduction as described in Treas. Reg. 1.165-2(a). To qualify as an abandonment, there must be intent to abandon and some overt act evidencing that intent. Dezendorf v. Commissioner, 312 F2d 95 (1963). These elements would normally be present in the case of deliberate non-use of a slot and forfeiture to the FAA under the use-or-lose provision. The involuntary withdrawal of a slot would also generally evidence a closed transaction. FAA records will show a definite point at which the slot reverted, fixing the timing of the loss. We would not regard an individual slot as an inseverable portion of some larger asset (e.g., all the taxpayer's slots, other airport assets, etc.), such that its forfeiture would only mark a shrinkage in the value of some greater asset.
The 'closed transaction' requirement has been at issue in a number of situations in which certain government-created exclusive rights were later modified or terminated. The question has arisen, for example, when deregulation has decreased the value of a formerly exclusive privilege, or when one beneficial aspect of a license or other government-granted right, such as transferability, has been modified or restricted. See, e.g., Beatty v. Commissioner, 46 TC 835 (1966) (no loss when transferability of state liquor licenses was restricted); Rev . Rul. 84-145, 1984-2 CB 47 (no loss with respect totaxpayer-airline's CAB air route authority on deregulation of industry); Rev. Rul. 74-306, 1974-2 CB 58, considered in * * * , GCM 35727, I-5142 (March 15, 1974) (no loss on lifting of cotton acreage allotment penalties). COMPARE Trucking Deregulation--Effect on Operating Rights, GCM 38619, 1-337-80 (Jan. 21, 1981) WITH section 266 of the Economic Recovery Act of 1981, PL 97-34 (devaluation of ICC operating authorities). The two situations we are considering here, however, are distinguishable. The loss of a slot, whether through the operation of the 'use-or-lose' provision or FAA withdrawal, represents more than simply a diminution in value; the taxpayer has parted with all rights to use, sell, lease, or otherwise exploit the slot.
It should be noted that under section 165(b) of the Code and Treas. Reg. 1.165-1(c) the amount of loss allowable as a deduction is limited by the taxpayer as adjusted basis in the property. As discussed above, an incumbent slot-holder that received its slot from the government rather than by purchase will typically have no basis in that slot, and the reversion of a slot for such a taxpayer would therefore have no tax consequence.
b. CHARACTER OF LOSS.
Assuming that the reversion of a slot to the government gives rise to a deductible section 165 loss, and the taxpayer has basis in the slot, one final question is whether that loss will be ordinary or capital in nature.
Section 165(f) states that losses from sales or exchanges of capital assets shall be allowed only to the extent allowed in sections 1211 and 1212. Section 1211 limits the deduction for capital losses. Section 1211(a), which applies only to corporations, allows a deduction for losses resulting from the sale or exchange of capital assets only to the extent of gains from the sale or exchange of capital assets. Section 1212 provides for capital loss carrybacks and carryforwards.
As discussed above under Issue 3, there are circumstances in which a slot will be an ordinary asset in a taxpayer's hands. Since section 165(f) only applies to capital assets, the general rule of section 165(a) would call for a deduction against ordinary income in the year of the loss in such cases.
Moreover, even if a slot qualified as a section 1221 capital asset, a loss stemming from reversion pursuant to the 'use-or-lose' or withdrawal provisions would normally be ordinary in nature because the 'sale or exchange' requirement in section 165(f) would not be met. The courts have interpreted the term 'exchange' as requiring that some benefit be received in return for what was lost. If, in fact, a slot- holder simply abandoned a slot or was required to forfeit a slot by the FAA, without receiving any benefit in return, there would be no 'sale or exchange'. It should be noted, however, that the courts have adopted a fairly broad concept of what constitutes an 'exchange' in this context. In Yarbro v. Commissioner, 737 F2d 479 (5th Cir. 1984), for example, the court held that the abandonment of real estate subject to a mortgage was a 'sale or exchange' giving rise to a capital rather than an ordinary loss because the taxpayer was relieved from the obligation, even though the mortgage was nonrecourse and the benefit did not proceed from the recipient of the property. See also Fancher v. United States, 62-2 USTC paragraph 9819 (WD SD 1962) (cancellation of taxpayer's liquor license actually a 'sale or exchange' because license was reissued to purchaser of taxpayer's liquor business pursuant to a prior understanding). Thus, forfeiture or withdrawal of a slot would result in an ordinary loss to the extent of basis-- whether or not it was a capital asset--unless, on the facts, there was some benefit to the slot-holder or other indication of a 'sale or exchange'.
James F. Malloy
Alan R. Fraser
Technical Assistant to the Director
END OF DOCUMENT
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